The absolute return investment approach
by Rahul Khasgiwale

This article represents the opinion of Standard Life Investments Inc.

In January of 2010, a portfolio of global stocks could have delivered a three year compound net return of -9% and still beaten the (MSCI Global) benchmark. On January 29, 2010, the three year return of the MSCI Global Index was -9.3%. It was clear that relative return fund managers fund managers who measure their success in relation to the performance of a benchmark index were being guided by failing or negatively performing benchmarks. In the midst of one of the most volatile periods in financial history, investors reeling from the 2008 crisis looked at the relative return model and thought there must be another way.

Absolute return funds have found a new popularity among investors. These funds offer the potential for consistent, positive returns as they give portfolio managers more scope to diversify and deliver returns from a variety of strategies. They normally use cash as a benchmark with a target return over and above this. The GARS strategy takes a multi-asset, multi-strategy approach and seeks to deliver consistent, positive returns in all market conditions. The Standard Life Global Absolute Return Strategies Fund1 has been offered to eligible investors in Canada since April 2013. Standard Life Investments originally launched GARS in the UK in 2006 as a solution for Standard Life Group’s own defined benefit staff pension plan. The success was compelling enough to capture the attention of institutional investors in Europe, Asia, Australia, the US and Canada. It has also positioned GARS as a globally recognized absolute return strategy with over C$58 billion under management (as at December 2013) and the fund has earned a multitude of industry awards. By aiming to deliver consistent positive returns, this fund offers accredited investors an alternative to traditional equity or fixed income portfolios. What makes the fund so popular with investors around the world?

An absolute return target
We believe that investors put their money to work because they want positive returns, rather than because they want to beat a particular benchmark. At Standard Life Investments, GARS has a target return of cash +5% per annum (gross of fees) over rolling three-year periods.2 At the same time, the portfolio manager expects volatility to be less than in a conventionally managed global equity portfolio with similar long-term return objectives. The portfolio managers at Standard Life Investments aim to construct a portfolio that is expected to have lower risk of volatile assets like global equities, but still achieves a similar long term return. For years, the investment community has upheld the maxim that “a good portfolio is a diversified portfolio”. But diversification doesn’t stop with a global perspective and a mixture of asset classes. Perhaps the most striking feature of the Standard Life Global Absolute Return Strategies Fund is its approach to portfolio diversification. Traditional funds may seek diversification through geographic regions or sector allocation, and as an advisor you may recommend that your clients diversify across asset classes – ensuring that fixed income, equities and perhaps real estate are all represented in their portfolios. But for the 35-strong multi-asset investing team who are responsible for the GARS Fund, this isn’t enough.

It’s a diverse world of opportunities
GARS derives positions from different strategy styles. First of all, the portfolio managers can add market returns from traditional asset classes, including equities, bonds and listed property. These are expected to provide long-term returns superior to cash and we actively manage weightings among these asset classes depending on Standard Life Investments’ macroeconomic outlook. Since the GARS portfolio is not aligned with any benchmark, the fund can hold as much or as little of these types of investments as the multi-asset team sees fit. Most importantly, the multi-asset investing team is not obliged to hold any of them at all. They also, on occasion, seek to enhance returns from these asset allocations through in-house security selection capabilities – also known as seeking alpha. Taken together, traditional exposures combined with security selection delivers a traditional multi-asset portfolio. These two sources could potentially produce positive returns in a number of economic scenarios. However, as seen in the case of balanced and diversified growth portfolios, this is insufficient in isolation. Therefore, to achieve true diversification and the potential for positive returns in all economic conditions, the team uses more advanced strategies, which it terms ‘directional’ and ‘relative value’.

Directional strategies are based on cyclical market opportunities relating to views on asset classes such as foreign exchange, interest rates and inflation. This type of strategy is often unavailable to traditional portfolios as these asset classes do not offer a long-term reward for being held continuously. However, the team expects this strategy to provide diversification against other strategies we are running. Relative value strategies allow the multi-asset investing team to take advantage of the differences in behaviour between two normally similar markets. Consequently, such relative value strategies can provide further levels of diversification as they are not directly exposed to the overall direction of the underlying market.

In managing this type of portfolio, the multi-asset investment team needs to analyze the individual contribution of each strategy to ensure that no individual strategy dominates the risk profile. This involves a multilayered risk management approach which utilizes the careful and ongoing analysis of experienced specialist teams.

Equity markets since 2008 have been the embodiment of the old Chinese curse “May you live in interesting times”. The unprecedented volatility that we saw during the financial crisis has led to an environment of uncertainty. Some investors may look at historical volatility levels of global stock markets and feel a lack of trust. The absolute return model, historically associated with hedge funds and “alternative” strategies, has become the refuge of investors seeking to move away from benchmarks which have let them down. Now investors have a choice between relative return portfolios and absolute return portfolios.

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1 The Fund invests substantially all (up to 100%) of its assets in Class Z shares of Standard Life Investments Global SICAV Global Absolute Return Strategies Fund (the “Underlying Fund”). The Underlying Fund and/or the Fund are not guaranteed, are not capital protected products and are not substitutes for cash or deposits. In order to achieve its investment objective the Underlying Fund will make extensive use of derivatives. In this article the “GARS Fund” refers to the underlying Fund.

2 Cash is defined as the 6-month Canadian Dealer Offered Rate (CDOR). There is no guarantee that the performance target will be attained over this or any time period.